Weekly Wrap-up: The Home Stretch!

By: Adam Oliensis | Mon, Sep 11, 2006
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Dear Speculators,

Last week the Dynamic Trading System netted position gains for its auto-traders of +23.9% and +5.3% in the E-Mini SPX and E-Mini NDX markets. The System has netted. +418% in position gains and with +114% in net total return since inception of our model portfolio in July 2005. If you would like a FREE ONE-MONTH TRIAL or to read more about The Dynamic Trading System in the Index Futures markets CLICK HERE.

(Note: All trades were executed in customer accounts in real time on the Dynamic Trading System's signals. However, because these results are representative of a compilation of accounts (and not one single account) and trades were executed by the Futures Commission Merchants and/or Securities Brokers who held limited power of attorney for the customer accounts, and not directly by The Agile Trader or by Dog Dreams Unlimited Inc., results are, for all regulatory and compliance purposes, hypothetical, with all disclosures and caveats applicable as disclosed below. Please see the Important Disclosures below my signature. -AO)


Our forecast for stock market's behavior as it heads toward the terminus of the current 4-Year Cycle (red line below) continues to be on track.

This chart tracks all the SPX's 4-Yr Cycles since 1962, scaled as percentage gains off the cycle lows. Each cycle begins with the low formed between Sep. 30 and Nov. 19 of Year One of the cycle (1962, 1966...2002, 2006). The current cycle (red) is moving toward its terminus, having completed trading-day #985, with roughly 23 trading-days to go, give or take a few weeks.

I've circled the 5 "middling" iterations of the cycle above. And on this next chart we've zoomed in on those 5 iterations.

As you can see, the 4 prior middling cycles have all begun very tradable declines between trading-day #992 and #996. We have been anticipating that the current cycle will show properties and characteristics not terribly dissimilar from the others on this chart, and our baseline forecast is still for weakness between now and mid October.

Since the summer lows we have been expecting that the SPX would rally up for a light-volume test its spring high near 1326 (+65% on this chart), before re-testing those summer lows (1220ish) in the September - October time frame. And that continues to be our baseline forecast.

That said, we have also cautioned that our view of the market's probable course could be altered by a breakdown in Oil and/or Gold prices, strength in the price charts of both commodities having been exerting inflationary pressures on the US economy. (The stock market does not like inflation!)

Well, this price chart of October Crude Oil futures shows that key support in the $68-$70 band has broken to the downside. This breakdown now generates a target of $60-$62.

And what has caused this breakdown? Not the actual near-term supply/demand picture. But rather positive developments in international negotiations with Iran (which brings down the risk premium in Crude prices) and the news that potentially significant new oil and natural gas reserves have been discovered in the Gulf of Mexico.

The following chart of October Gold futures also shows a significant breakdown.

With Gold now below $600 for the first time since June, the trip up and over $700 looks more and more like a purely speculative bubble, and the chances begin to decrease that the price spike was forecasting for hugely elevated inflation levels. (Targets of $560 and perhaps $520 now come into play.)

In short, the breakdowns on these commodity charts suggest that the inflationary/speculative excesses that had been operative in the commodities markets are now clearly being wrung out, and that the Fed may have less to worry about on the inflation front than it did as recently as July.

Of course the key questions for investors and traders in stocks is whether all this is good for the stock market. In our view the answer is broadly, and for the long term, definitely YES!

However, in the September-October time frame our answer must be more qualified and cautious. Fundamentally cheaper commodities and lesser inflationary pressures are good. But, given the intense and dogmatic (almost religious) embrace by many investors of the long-term prospects for Energy stocks, a break in Energy prices could very well cause the kind of aggressive break in stock index charts that is often associated with the home stretch of the 4-Year Cycle.

This chart of the SPX Energy Sector (XLE) shows marked underperformance over the past month. (The Relative Strength line is XLE's price divided by the SPX price. When this line is moving higher then XLE is outperforming SPX and when it's moving lower, then XLE is underperforming SPX.)

If we see XLE break below $50, then the chart will generate a target of $40.

Now, let's put on our "What If" thinking caps and ask ourselves, "What if Oil and Energy Stocks break down along with Gold and Gold Stocks?" With the preponderance of institutions and Hedge Funds having swallowed the Commodities Boom Kool Aid (the same way the Tech Revolution Kool Aid was the beverage of choice in the latter '90s), aren't we exposed to the possibility of some extreme stock-market disruption (institutional failure?) in the weeks ahead?

These kinds of things are hard to predict with reliability and/or accuracy. But it is our view that the risks are probably significantly elevated between now and the latter part of October.


Now, let's turn our attention for a minute to what one might reasonably expect out of stock market performance AFTER the anticipated 4-Yr Cycle Low forms, most probably this autumn.

In this next chart we zoom in on the first half of the 4-Yr Cycle, examining more closely the first 525 trading days of the past 11 cycles.

Now, here's the remarkable statistic: In 9 of the last 11 iterations of the cycle, 525 trading days into the cycle (circled on the chart above), the SPX has seen a gain of between 37% and 54%. Put differently, 82% of the time the SPX has rallied 45-46% (give or take 9%) in 25 months.

It sure looks like it would make sense to get bullish on the stock market at some point this fall, and to remain in an essentially bovine posture for the next couple of years.

We would continue to expect that the recent leaders (Energy, Materials, Metals, Utilities) would have difficulty in continuing to lead over the next couple of years. And we would look for leadership to develop in those sectors that have lagged: Tech (especially Semiconductors) and Health Care, for example.

Note: both the Semis and Health Care sectors have been developing positive Relative Strength characteristics ahead of the expected 4-Yr Low. And we would expect those sectors to maintain some positive characteristics through a rocky period in the weeks ahead.

Best regards and good trading!

 


 

Adam Oliensis

Author: Adam Oliensis

Adam Oliensis,
Editor The Agile Trader

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